The Fragile Stability of Monetary Disorder

Unsettled conditions prevail throughout global financial markets, although
U.S. stocks were generally little changed. The Dow, S&P500, Transports
and Utilities were largely unchanged for the week. The Morgan Stanley Cyclical
index dipped 0.5%, while the Morgan Stanley Consumer index gained 1%. The broader
market was flat, with the Russell 2000 and S&P400 Mid-cap indices about
unchanged for the week. Technology stock remained under pressure. The NASDAQ100
dipped 0.5%, and the Morgan Stanley High Tech index was hit for 2%. The Semiconductors
were hammered for 5%. The Street.com Internet and NASDAQ Telecommunications
indices were both down 1%. The Biotechs were about unchanged. Financial stocks
performed better, with the Broker/Dealers up 1% and the Banks up 1.5%. Bullion
gave back only 70 cents of last week's strong gain, while the HUI gold index
added 3%.

Japanese 10-year JGB yields dropped 12 basis points for the week to 1.57%, "the
biggest two-week gain in more than five years," according to Bloomberg. Brazilian
benchmark bond yields sank 42 basis points to 9.93%, as the Brazilian real
enjoyed its third straight week of gains against the dollar. Mexican govt.
yields declined 4 basis points this week to 5.51%. Russian 10-year Eurobond
yields were unchanged at 6.40%.

Freddie Mac posted 30-year fixed mortgage rates dropped 14 basis points this
week to 5.85%, the lowest level since the week of April 9. Fifteen-year fixed
mortgage rates declined 16 basis points to 5.24%, down 25 basis points in two
weeks. One-year adjustable-rate mortgages could be had at 4.08%, unchanged
for the week. The Mortgage Bankers Association Purchase application index dipped
2.5% last week. Purchase applications were up about 8% from one year ago, with
dollar volume up 16%. Refi applications rose about 3%. The average Purchase
mortgage was for $214,500, and the average ARM was $291,300. ARMs accounted
for 34.2% of applications last week.

The dollar was pounded today after the release of June's terrible trade data.
Gaining 1.7%, the Canadian dollar enjoyed its biggest one-day gain since 1988
(from Bloomberg). The dollar index declined 0.5% this week. The New Zealand
dollar, Argentine peso, and Norwegian krone enjoyed about 2% gains for the
week. The South African rand sank 5%.

Commodities Watch:

August 13 - AFP: "China's imports of crude oil in the first seven months
rose nearly 40 percent from a year ago as the energy-hungry economy expanded
at close to double-digit levels, state press reported. In the seven months
to July crude imports rose an annualised 39.5 percent to 70.63 million metric
tones... Crude oil imports rose 39.3 percent year-on-year to 61.02 million
tons in the first six months... The world's second largest oil consumer
after the United States has seen oil imports soar as flagging domestic production
has failed to keep up with booming economic growth and demand for gasoline
in the auto market... The world's fastest growing economy imported 91 million
tonnes of crude oil last year, a 31.3 percent increase over 2002."

August 10 - MarketNews (Gary Rosenberger): "Steel prices have skyrocketed
into new record territory, driven by surging raw materials costs and
domestic and global demand, with the trajectory seemingly unabated by this
summer's economic hiccup, say steel industry executives. Hot-rolled sheet,
a benchmark product, has tripled to about $800 ton (including surcharges)
after having sunk to around $260 a ton early in 2003..."

August 11 - MarketNews (Gary Rosenberger): "U.S. lumber prices are seesawing
at five-year highs on record demand from residential building and remodeling
and tight supplies fomented by transportation bottlenecks and diminished
capacity at mills, industry officials say... Average monthly framing lumber
composite prices hit a cyclical peak of $456 per thousand board feet in May,
retreated to $423 in June then sharply turned up to $472 the first week of
August, 52% above the prior-year price of $311..."

August 11 - Bloomberg (Antony Sguazzin and Dylan Griffiths): "De Beers, the
world's biggest diamond company, said it will raise the price of rough diamonds
by an average of 5 percent this month as jewelry demand remains 'strong' for
the rest of the year. The increase, De Beers's third this year, follows a 7
percent increase in retail diamond sales in the year's first six months..."

Copper jumped 4% today, trading to a three-month high. Weighed down by week
grain and soybean prices, the CRB index added 0.5% (y-t-d gains of 5.4%). October
crude surged $2.51 to a record $46.03. The Goldman Sachs Commodities index
jumped 2.5% to the highest close since the spike on June 1. Year-to-date gains
increased to 21%, with gains from 2002 lows of 95%.

China Watch:

August 13 - Bloomberg (Philip Lagerkranser and Wing-Gar Cheng): "China's exports
and imports rose 34 percent from a year earlier last month, the official Xinhua
News Agency reported... Exports reached a record $51 billion and imports climbed
to $49 billion, leaving a trade surplus of $2.04 billion... Overseas sales
rose 47 percent in June and imports jumped 51 percent..."

August 12 - Bloomberg (Wing-Gar Cheng): "China's central bank said wholesale
prices of energy products including crude oil, coal and power rose in July
because of shortages and surging demand. Crude oil prices rose 8.9 percent
in July from a year earlier and were 1.2 percent higher compared with June,
People's Bank of China said... Prices of coal rose 40 percent from a year earlier
and gained 0.6 percent from June..."

August 12 - Bloomberg (Philip Lagerkranser and Tian Ying): "China's consumer
prices rose last month at their fastest pace in more than seven years as
food costs surged, making it harder for the central bank to avoid raising interest
rates.... Consumer prices rose 5.3 percent from a year earlier after climbing
5 percent in June... That's the biggest gain since February 1997..."

August 11 - Bloomberg (Philip Lagerkranser and Tian Ying): "China's producer
prices rose 6.4 percent from a year earlier last month as crude oil costs surged.
The gain matches June's increase, which was the biggest in at least five
years..."

August 13 - Bloomberg (Philip Lagerkranser and Tian Ying): "China's retail
sales rose 13.2 percent last month as rising incomes made cars, cell phones
and computers more affordable... The gain followed a 13.9 percent increase
from a year earlier in June..."

August 9 - Bloomberg (Allen T. Cheng): "China's property prices will rise
at a similar pace in the second half to the first six months even as the government
clamps down on project loans and approvals, the state-run Xinhua news agency
reported... Housing demand remains particularly strong in the cities of Beijing,
Shanghai and Guangzhou, where prices will continue to surge, the report said... Home
prices in 35 major cities rose by an average of 10.4 percent from a year earlier
in the second quarter, led by a 21.4 percent increase in Shanghai..."

August 9 - Bloomberg (Michele Batchelor): "The number of people in China's
cities of Beijing, Shanghai and Guangzhou holding a credit card increased to
22 percent of the population at the end of February, according to a survey
by ACNielsen."

August 10 - Bloomberg (Philip Lagerkranser and Tian Ying): "China's industrial
production rose in July at the slowest pace in a year as government restrictions
on bank lending curbed manufacturing of cars, cement and glass in the world's
fastest-growing major economy. Production rose 15.5 percent from a year earlier
after climbing 16.2 percent in June..."

August 11 - Bloomberg (Philip Lagerkranser and Tian Ying): "China's export
growth flowed more than expected last month as higher fuel costs curbed spending
in the U.S. and sliding wages hurt Japanese demand. Exports rose 34 percent
from a year earlier to a record $51 billion after jumping 47 percent in June..."

August 11 - Bloomberg (Philip Lagerkranser and Tian Ying): "China's money
supply grew last month at its slowest pace in two years after the government
ordered banks to curb lending to curb investment by state-owned companies.
M2, which includes cash and all deposits, expanded 15.3 percent from a year
earlier to 23.8 trillion yuan ($2.9 trillion) after growing 16.2 percent in
June..."

Asia Inflation Watch:

August 9 - Bloomberg (Yu-huay Sun): "Taiwan's exports rose by about a quarter
for a second month in July as the island's electronics makers shipped more
flat-panel displays, semiconductors and laptop computers to China. Shipments
increased 26 percent from a year earlier to $14.7 billion after climbing 25
percent in June..."

August 11 - Bloomberg (Seyoon Kim): "South Korean exports will probably rise
36.5 percent from a year earlier to about $21 billion this month, the commerce
ministry said. Exports, which account for about two-fifths of Asia's third-largest
economy, rose 38 percent in July..."

August 10 - Bloomberg (Amit Prakash): "Singapore's economy expanded a faster-than-expected
11.9 percent in the second quarter on surging exports by manufacturers... Annual
growth in gross domestic product in the quarter ended June 30 outpaced the
government's initial estimate of 9.1 percent..."

August 9 - Bloomberg (Heather Walsh): "Malaysia's industrial production rose
at a faster pace in June as manufacturers and power producers increased output
to meet rising demand. Production at Malaysia's factories, mines and utilities
expanded 13.3 percent from a year earlier, also up from a revised 12.5 percent
increase in May..."

August 12 - Bloomberg (Kartik Goyal): "India's industrial production rose
faster than expected in June as record farm incomes and the cheapest credit
in three decades boosted demand for manufactured goods. Output at factories,
utilities and mines rose 7.3 percent from a year earlier, faster than May's
revised 6.7 percent rate..."

August 13 - Bloomberg (Kartik Goyal): "Indian inflation, measured by the rise
in wholesale prices from a year earlier, accelerated to 7.61 percent in the
week ended July 31 from 7.51 percent in the previous week... It was the
highest since Feb. 17, 2001..."

Global Reflation Watch:

August 10 - Bloomberg (Greg Quinn): "Canadian new home prices rose in June
at the fastest annual pace since February 1990, surging 6.2 percent as builders
raised prices to cover higher costs for labor, drywall and lumber."

August 9 - Bloomberg (Kevin Carmichael): "The value of construction permits
issued by Canadian municipalities surged 27.1 percent in June, six times more
than economists expected, led by record demand for apartments and condominiums."

August 11 - Bloomberg (Lily Nonomiya and Julie Ziegler): "Japan's economy,
the world's second largest, will expand at its fastest rate in more than
a decade this year and is likely to continue growing for the next few
years, the International Monetary Fund said. Economic growth is projected
to reach 4.5 percent this year, compared with an April forecast of 3.4 percent..."

August 9 - Bloomberg (Sam Fleming): "U.K. house-price inflation accelerated
in June to the fastest annual pace for 10 months as higher interest rates failed
to damp demand for property, a government survey showed. The average cost of
a home rose 13.9 percent in June compared with the same month last year to
173,756 pounds ($320,241)..."

August 12 - Bloomberg (Sam Fleming): "English new home starts rose 9.5 percent
in the second quarter of the year from the same period in 2003, according to
government figures, as homebuilders boosted construction amid 20 percent house-price
inflation."

August 12 - Bloomberg (Eduard Gismatullin): "Russia will boost its defense
spending by 40 percent to 700 billion rubles ($23.9 billion) next year, Interfax
reported, citing Finance Minister Alexei Kudrin. Salaries for servicemen will
be raised by more than 50 percent, the news service said."

August 11 - Bloomberg (Simone Meier): "Swiss retail sales in June increased
the most in three years as households boosted spending ranging from furniture
to computers and watches. Sales rose an inflation-adjusted 6.2 percent from
the year-earlier period after a 3.5 percent drop in May..."

August 11 - Bloomberg (Andrew J. Barden): "Mexican industrial production rose
for a seventh month in June as manufacturing companies increased production
to meet rising U.S. demand. Industrial output, which includes manufacturing,
construction, mining, and utilities, rose 5.2 percent, said Mexico's Finance
Ministry...compared with the median estimate of 4.5 percent..."

August 13 - Bloomberg (Romina Nicaretta): "President Luiz Inacio Lula da Silva
was told Brazil's gross domestic product grew between 4.5 percent and 5 percent
in the first half of the year compared with the same period a year earlier,
Folha de S. Paulo newspaper reported... The 5 percent growth in GDP would be
the biggest growth for that period in nine years..."

August 11 - Bloomberg (Jeb Blount): "Brazil's inflation rate surged to a 15-month
high in July as rising demand for machinery, steel and other goods led manufacturers
that are running near full capacity to boost prices. Consumer prices, as measured
by the government's IPCA index, rose 0.91 percent in the month after rising
0.71 percent in June... A 2.5 percent surge in gasoline prices at the pump
led the increase in the month."

August 9 - Bloomberg (Heather Walsh): "Chile's trade surplus rose in July
after prices for copper, Chile's top export, surged 56 percent in a year because
of stronger demand in China and the U.S."

California Bubble Watch:

August 11 - MarketNews (Chris H. Sieroty): "After a drawn-out budget battle
last month that left lawmakers and the governor bruised, August, so far, has
been relatively kinder to California. State Controller Steve Westly announced
late last week that state revenues, which had come in below forecast for
most of the year, totaled $4.05 billion, a 9.1% jump from the same month last
year."

U.S. Bubble Economy Watch:

August 10 - Bloomberg (Stephen Cohen): "A record number of the financial analysts,
bankers and traders who took the Chartered Financial Analyst exam in June failed
the test. Almost two-thirds of the 24,241 people who took the first of the
three tests needed for certification didn't pass, according to the CFA Institute...
The institute said it was the fifth straight year that the passage rate declined.
In 1999, 36 percent of candidates flunked; this year, 64 percent failed... More
people than ever are taking the test, with an estimated 85,000 enrolled for
all levels of the June exam."

August 10 - Bloomberg (Michael B. Marois): "U.S. states tax revenue increased
for a third quarter in a row because of an improving economy, helping many
states meet or exceed budget forecasts for their fiscal year... State tax
revenue collections increased 11.4 percent in the April through June quarter
compared with the same period last year, according to a report by the Nelson
A. Rockefeller Institute of Government... In fiscal 2005, the projected
budget gap for all U.S. states was $36.3 billion, less than half that of a
year earlier..."

August 9 - Bloomberg (Tony Capaccio): "Rising costs for the Pentagon's largest
aircraft, ship, space and ground combat systems are likely to result in major
cuts in weapons-buying budgets, the Congressional Research Service warned in
a new report. Defense analysts, including those with the Congressional Budget
Office, have warned since the 1990s of a looming budget crunch, with too many
systems chasing too few dollars. The crisis is coming to a head because
of the cumulative impact of escalating costs recently documented in nine
top programs..."

July Retail Sales were up 6.5% from July 2003. Ex-autos, sales were up 7.8%.
Inflation effects were conspicuous, with Gasoline Stations reporting an 18.6%
rise from one year ago, with Building Materials up 10.9%. Furniture sales were
up 6.7% and Electronics 6.8%. Eating and Drinking establishments enjoyed an
8.4% increase from July 2003. In contrast, Department Store sales were down
1.7%.

Our federal government ran a $69.2 billion deficit during July, up from the
year ago $54.2 billion. After 10 months of the fiscal year, the y-t-d deficit
of $395.8 billion is running 22% ahead of last year. And while y-t-d Receipts
are up 4%, Total Spending has jumped 7.2%. By largest category, National
Defense spending is running 14.8% higher than last year, Social Security 4.3%
higher, Income Security 1.2% higher, Medicare 8.6% higher, and Health 10.2%
higher.

Mortgage Finance Bubble Watch:

August 12 - Bloomberg (Kathleen M. Howley): "U.S. home resales rose 9.1 percent
to a record in the second quarter as the economy improved and people rushed
to secure the lowest mortgage rates of the year, according to a report from
the National Association of Realtors. Sales of existing single-family homes,
condominiums and cooperatively owned apartments increased to an annualized,
seasonally adjusted pace of 7.79 million units from 7.14 million in the first
three months of the year, NAR said. The previous record was a 7.36 million-unit
pace in the third quarter of 2003..."

August 9 - Bloomberg (Kathleen M. Howley): "The National Association of Realtors,
the U.S. industry's largest trade group, increased its estimate for home sales
for the eighth time this year... Sales of existing homes probably will reach
6.45 million, higher than the 6.31 million the Washington group forecast a
month ago. New-home sales will be 1.2 million, more than NAR's previous forecast
of 1.16 million. Those results would make this year the best on record for
both categories."

August 9 - "The exceptionally strong performance of home sales this year,
combined with a favorable economy and affordability conditions, means the record
expected for housing this year will be larger than earlier projected, according
to the National Association of Realtors. David Lereah, NAR's chief economist,
said the biggest surprise this year has been the performance of interest rates...
'The momentum of existing-home sales this year is unprecedented, rising
steadily each month and hitting a new record in June,' Lereah said. 'In addition,
new-home sales have been at or near-record levels each month in 2004.' NAR
forecasts existing-home sales to rise 5.7 percent this year to 6.45 million,
well above the record 6.10 million in 2003. New-home sales also should hit
a record, increasing 10.8 percent to 1.20 million in 2004. Housing starts are
expected to come in at 1.90 million, 2.6 percent above 2003, and would be the
strongest level of housing construction since 1978."

August 12 - "Strong housing market fundamentals propelled total existing-home
sales to the highest pace on record in the second quarter, according to the
National Association of Realtors. Sales rose by double-digit rates in 34 states
and the District of Columbia compared to the same quarter in 2003 and no state
recorded a decline... The strongest year-to-year increase was in Nevada, where
the second quarter resale pace rose 32.5 percent over the second quarter of
2003. Next came Idaho, which rose 31.0 percent from a year ago. Arizona posted
the third highest increase, up 25.1 percent from last year's second quarter
rate. Regionally, the West experienced the strongest increase with sales activity
in the second quarter at a record annual rate of 2.17 million units, up 19.8
percent from a year ago. After Nevada, Idaho and Arizona, the next highest
increase was in Colorado, where existing-home sales rose 23.5 percent; Oregon
resales were up 21.8... The South, with a record resale rate of 3.17 million
units, posted a 17.5 percent rise...The strongest increase was in North
Carolina, where the resale pace was 24.8 percent higher than the second quarter
of 2003. South Carolina was up 23.5 percent, while Florida rose 22.8 percent
in the last year. In the Northeast, total existing-home sales jumped 12.6 percent
to a record pace of 903,000 units in the second quarter... Leading the region
was Connecticut, where existing-home sales rose 23.3 percent... At the same
time, both Massachusetts and New Jersey increased 22.5 percent while Maine
was up 20.3 percent. In the Midwest, total existing-home sales increased 10.1
percent to a record annual pace of 1.54 million units... The strongest increase
in the region was in North Dakota, with a gain of 19.8 percent in resale activity...followed
by Kansas with a rise of 15.2 percent and Minnesota, which increased 13.8 percent."

August 12 - "Home prices in the second quarter increased at a strong rate
in most metropolitan areas in comparison with the same period a year earlier,
according to the latest survey by the National Association of Realtors. The
association's second-quarter metro area home price report, covering changes
in 128 metropolitan statistical areas,* shows 49 metros with double-digit annual
increases in median existing-home prices and 11 metros with generally small
price declines. David Lereah, NAR's chief economist, said that 49 is the largest
number of areas ever to experience double-digit annual price gains. 'A tight
supply of available homes in a record sales market has been favoring sellers.'
The national median existing-home price was $183,800 during the second quarter,
up 9.1 percent from the second quarter of 2003... The strongest increase was
in Las Vegas, with a median price of $269,900, up 52.4 percent from the second
quarter of 2003. Next came Anaheim-Santa Ana (Orange Co., Calif.), at $655,300,
up 38.7 percent. Third was Riverside-San Bernardino, Calif., where the second
quarter median price of $294,500 was 38.5 percent higher than a year earlier." Other
notable gains included San Diego 37.5%, Los Angeles 30.4%, and Miami 25.9%.

August 12 - "Sales of single-family existing homes in Florida remained at
record levels during second quarter 2004 with a 28 percent increase in resale
activity compared to the same time last year, according to the Florida Association
of Realtors. Statewide, a total of 73,437 homes sold during the second quarter,
which surpassed the volume from the same period in 2003 by more than 15,000
homes. The statewide median sales price for second quarter 2004 rose 18 percent
to $181,800; a year ago, it was $153,600."

The Federal Home Loan Bank System (FHLB) expanded assets by $39.1 billion,
or 18% annualized, to $896.1 billion during the second quarter. This was
the largest increase since the fourth quarter of 1999. Total Assets were
up $73.3 billion over the past two quarters, also an 18% growth rate. And
while Assets were up $87.2 billion from one year ago (11%), second-quarter
Net Income increased $79 million to $530 million. Since the beginning of
1998, Total Assets have increased 157%.

Countrywide Financial enjoyed another booming month. The company posted Purchase
Fundings of a record $17.5 billion, up 31% from July 2003. ARMs accounted
for a record 57% of fundings, with the dollar volume of ARM loans almost double
the year ago level. But with refi fundings down 68% y-o-y, Total Fundings
were down 43% y-o-y. Home Equity Fundings were a record $2.84 billion, up
67% y-o-y. Subprime Fundings were up 119% y-o-y to a record $3.89 billion.
Countrywide Bank Assets were up 103% y-o-y to $28.6 billion.

The Bond Market Association's Research Quarterly was released this week with
the headline "Bond Issuance Stable in Q2 at $1.45 Trillion." While debt issuance
has generally lagged last year's pace due to the decline in mortgage and corporate
debt refinancings, net Credit growth continues at record levels. Some details
from the report:

"Treasury gross coupon issuance totaled $427.0 billion in the first half
of 2004, up from the $328.4 billion issued in the same period one year ago." "Daily
trading volume of Treasury securities by primary dealers averaged $501.3
billion during the first half of 2004, up 19.3 percent from...the same period
one year ago."

"Asset-backed issuance increased 38.1 percent, to $389.1 billion, up from
the $281.7 billion issued during the same period one year ago." "Issuance
of asset-backed securities (ABS) is on pace to break the record $585.0 billion
set in 2003. During the first six months of 2004, ABS new issue activity
set a half-year record of $389.1 billion, a remarkable 38.1 percent higher
than the previous half-year record of $281.7 billion set last year...
Second quarter issuance was 7.0 percent higher than the first quarter of
2004, and 34.5 percent greater than the second quarter of 2003. The ABS market
offers investors a combination of safety, liquidity and stellar credit quality
as most of the securities carry a triple-A rating and pay a floating coupon...
The HEL (home equity loan) sector continues to dominate the ABS sector, accounting
for nearly half of total ABS volume in the first half of the year. New issue
activity totaled $192.8 billion for the period, up 68.9 percent from the
$114.2 billion issued in the first two quarter of 2003. Issuance increased
to $103.2 billion in the second quarter, up 15.2 percent from the [first
quarter]... The student loan sector continues to increase in size and surpassed
the credit card sector this quarter as the third largest ABS sector on issuance
volume. In the first half of the year, new issue activity of student loans
increased 32.8 percent, to $27.1 billion... Issuance of $16.9 billion in
the second quarter was 63.4 percent higher than the first quarter of the
year, and 54.5 percent higher than the second quarter of 2003."

"Volume in the mortgage-related securities market increased 33.4 percent,
to $536.3 billion in the second quarter when compared to the first quarter
of 2004."

"The average daily volume of total outstanding repurchase (repo) and reverse
repo agreement contracts totaled $4.66 trillion in the first half of 2004,
an increase of 20.4 percent from $3.87 trillion during the same period in
2003. Daily outstanding repo agreements averaged $2.71 trillion in the
first half of the year, an increase of 20.2 percent from the $2.26 trillion
through June 2004... Total repo and reverse repo average daily outstanding
volumes increased every month in 2004, with the exception of April... In
the first half of 2004, over $164.8 trillion in repo trades were submitted
by Government Securities Division participants, with average daily volume
of approximately $1.3 trillion."

"Net foreign purchases of U.S. fixed-income securities totaled $411.6
billion year-to-date through May 31, 2004, 40.3 percent higher than the
first five months of last year."

The Fragile Stability of Monetary Disorder

Atypical market developments again compel me to dive into some contemporary
monetary theorizing. The nature of contemporary finance and economies provides
some important nuances that often contradict conventional doctrine. Analysts
that fail to appreciate some of the intricacies of contemporary "money" and
Credit are left at a decided disadvantage. Hoping to make this more than an
academic exercise, I will direct my analysis to the current financial environment,
along with the ongoing "inflation vs. deflation" debate.

Interestingly, we are again in an environment of rather diametrically opposed
views on the rate of "money" growth. Some argue that money growth has slowed
significantly, while I have posited that we are in the midst of the "blow-off" in
monetary expansion. Looking at the latest Fed figures, I do see that M2 has
a rather tepid year-over-year increase of 4.2%. Yet the same Fed report has
M3 expanding at a notable 9.4% rate over the past 26 weeks. Additionally, issuance
of "money"-like asset-backed securities is booming at a record pace.

It is my view that, when it comes to contemporary monetary analysis (focusing
on the entirety of the financial sector and not just the banks), broader (M3)
is much better than narrower (M1 or M2). What's more, year-over-year money
growth calculations are rather tricky right now, as there was a significant "conversion" of
monetary liabilities into higher risk (non-money) instruments that resulted
in a decline in the "M's" during last year's fourth quarter (borrowers issued
long-term debt to pay down short-term borrowings, as lenders concurrently sought
higher-yielding instruments).

There are some other realities that cannot be ignored. The vast majority of
contemporary "money" is comprised of electronic journal entries (debits and
Credits). Of the almost $9.3 Trillion of M3, government issued currency accounts
for $686.2 billion, or 7.4%. The remainder is made up of liabilities issued
by various financial institutions, including Demand Deposits ($315 billion),
other Checkable Deposits ($183 billion) Savings Deposits ($3.42 Trillion),
Small Denominated Deposits ($795 billion), Retail Money Fund deposits ($736
billion), Institutional Money Fund deposits ($1.10 Trillion), Large Denominated
Deposits ($ 1.04 Trillion), Bank Repurchase Agreements ($517 billion), and
Eurodollar deposits ($345 billion). And there are now about $2.5 Trillion of
outstanding asset-backed securities.

Banks are only one of myriad institutions that issue monetary liabilities,
and reserve requirements are today virtually irrelevant to the process of issuing
new "money." A diverse group of financial institutions - including banks, GSEs,
savings & loans, insurance companies, brokerages, money market funds, finance
companies, "captive" finance units (i.e. GE, GMAC) and Wall Street structured
entities (special-purpose vehicles, CDOs, MBS, ABS) are all tightly linked
through the money and capital markets. These institutions issue new liabilities
to each other and expand assets (increase holdings of other's liabilities),
creating marketplace "liquidity" throughout the expansion process. Funds are
created and "transferred" among myriad institutions though adjusting journal
entries (debiting and crediting accounts), and there is today absolutely nothing
special about bank "money." Many types of financial "intermediaries" debit
and Credit accounts using the same processes as banks.

But having said all of that, the M's are only one facet of monetary analysis.
The examination and analysis of Credit are actually far the more important.
Traditionally, money supply (bank deposits) expanded right along with bank
lending (the commanding source of Credit growth). The Fed could manage Credit
expansion through adjusting bank reserve positions, and bank deposit expansion
was a good proxy for Credit growth. Generally, the monetary aggregates still
expand as Credit expands. But - as was demonstrated clearly last fall - there
are episodes where significant Credit growth is accomplished through the expansion
of non-monetary liabilities (longer-term, riskier debt instruments).

Sound analysis requires diligent observation of the nature and degree of lending
- what is being financed, to what extent, and to what end of Inflationary Manifestations.
Are new financial claims backed by productive investment; is new lending financing
asset inflation or financial speculation? Analysts of boom sustainability,
along with financial and economic fragility want to know! And just as we must
look to broad money as an indicator of the degree of Credit expansion, we must
think broadly when it comes to inflation as well. Inflation is a Credit phenomenon
with myriad and divergent manifestations.

There are a few things that should not be in dispute. First, total system
Credit growth remains massive and at record levels. Second, the Mortgage Finance
Bubble today dominates the Credit creation process, with historic over-lending
fueling housing inflation and over-consumption. The Credit system is extraordinarily
unbalanced; the economy is incredibly imbalanced; and today's news of June's
$56 billion trade deficit is indicative of the extreme nature of current maladjustments.
Third, there is a powerful confluence of unprecedented U.S. trade deficits,
huge speculative flows to non-dollar asset classes, and historically low global
interest-rates. Accordingly, the global liquidity backdrop today is as loose
as one could imagine. There is no mystery surrounding the inflationary
Asian boom or the spike in oil and commodity prices. Unstable financial markets
are, as well, no surprise. And with global liquidity abundant and central banks
almost universally quite accommodative, there is today good reason to assume
that surging energy and commodity prices will be "monetized" through heightened
global Credit excess. Inflationary pressures will continue to broaden.

Still, the old Inflation vs. Deflation debate is not much closer to being
resolved today than it was several years ago. It is, however, my view that
momentous developments over the past couple of years do add some degree of
clarity to our analysis. It should be apparent at this point that inflation
and general price instability will impact our lives more going forward than
they have in decades. Not only has the war on inflation not been won, it is
being lost. The enemy has dispersed and turned elusive, and there is absolutely
no acceptable strategy for regaining control of the theater of combat. The
Fed and global central bankers will, not irrationally or unjustifiably, continue
to view the risk of debt collapse much greater than the risks of inflation,
monetary disorder, and unstable markets. And the continuing environment of
downward pressure on technology and manufactured goods prices will support
central banker rationalizations.

Appreciating that inflation begets greater inflation, it is tempting today
to extrapolate significantly higher inflation over the coming years. And with
my view that the dollar will fall significantly from current levels, the likelihood
of heightened inflationary pressures does only increase. But is there a meaningful
risk of hyper-inflation developing? I don't think so, and in fact I view the
developments over the past two years as actually decreasing the probability
for hyper-inflation. While heightened general inflation pressure is the most
likely scenario, I would at this point expect the risk of a major pricing cataclysm
is more on the downside (systemic debt collapse) than upside (hyper-inflation).

In my mind, the key issues have always been the sustainability of the Credit
Bubble and with the risks associated with a Credit breakdown and resulting
economic dislocation. And with the Mortgage Finance Bubble having been nurtured
to "blow-off" extremes; with "money" supply expansion/intermediation having
gone to "blow-off" extremes; with leveraged speculation having gone to extremes;
with global over-liquidity having risen to "blow-off" extremes; and with extraordinary
Monetary Disorder having been unleashed at home and abroad, I certainly view
the probability for a devastating Credit collapse as much higher today than
it was 24 months ago - significantly higher.

Returning to monetary analysis, I believe I understand the nature of hyper-inflation.
Despite numerous complexities, it does very much revolve around the government
printing press and uncontrolled fiat money inflation. Yet this dynamic
has very little to do with contemporary "money" and Credit. And I think it
is important to appreciate that current inflation is also divorced from Federal
Reserve "printing" or "pumping." The expansion of the Fed's balance sheet has
been basically inconsequential in comparison to total system-wide Credit expansion.

The Fed does not today "control" money creation. It has, however, been too
successful in encouraging lending excess and inciting leveraged speculation.
Moreover, the Fed has nurtured the mushrooming of the U.S. financial sector,
and with it the "intermediation" of Trillions of risky loans into perceived
safe and liquid "money" and Credit instruments. But we need, today, to be very
cautious when it comes to extrapolating the Fed's capacity for inciting both
lending, speculating, and intermediation - the commanding forces underpinning
today's key inflationary manifestations. When financial crisis arrives - and
de-leveraging and disintermediation commence - the Fed will certainly aggressively
expand their balance sheet and incorporate "unconventional measures." But years
of runaway systemic excess (not to mention dollar vulnerability) leave the
Fed today a rather atrophied and timid little player confronting A Big & Nasty
Credit Bubble. The Fed will be surprisingly impotent in ameliorating bursting
Bubbles, and the notion of "pushing on a string" will become topical.

Why did NASDAQ collapse in 2000? Well, cumulative market and industry distortions/imbalances
from the preceding boom years - culminating with 1999's spectacular Monetary
Disorder and terminal "blow-off" excesses - ensured its eventual bust. It was
only a matter of from what level of excess and how spectacular the bust. Today,
very similar dynamics have come to apply with respect to the Mortgage Finance
Bubble. Out in California (and elsewhere), reckless excesses ensure a housing
Bubble collapse. But dangerous Bubble dynamics go way beyond mortgage finance.
The ongoing explosion of liabilities owed to our foreign creditors risk a run
on our currency and collapse in dollar confidence. The unparalleled ballooning
of leveraged speculation risks unstable markets and dislocation. The derivative
markets - where various market risks have been concentrated within a small
group of institutions employing dynamic-hedging strategies - present a very
real risk of systemic breakdown.

Not only do I view developments over the past two years as having significantly
upped the ante on the dangers of Credit collapse, I believe the character of
Fed-induced excesses and imbalances have significantly increased the likelihood
of markets eventually "seizing up" - the LTCM debacle having provided an omen
that should have been heeded. Today, with Bubble dynamics and speculative leveraging
at full intensity, any significant move to de-leverage or liquidate dollar
exposure would precipitate systemic liquidity crisis. And the way things are
currently developing, a dislocation in the dollar/currency markets would appear
to pose the greatest risk as the catalyst for such a financial dislocation.
Most unfortunately, the contemporary U.S. Credit system has demonstrated zero
capacity for self-regulation or adjustment.

The lack of a monetary "anchor" is a defining feature of contemporary finance.
There is no mechanism (gold standard, reserve requirements, lending restrictions)
to restrain issuance. Myriad financial institutions are capable of creating
liquidity (backed by almost any quality of loan), a powerful dynamic that continues
to be instrumental in sustaining the Credit Bubble. The "moneyness" of Credit
(the capacity to create perceived safe and liquid Credit instruments from risky
loans) is also a defining characteristic of contemporary finance. Combined, "anchorless" and "moneyness" have
been instrumental in fostering the U.S. Credit Bubble and, thus, financing
the U.S. Bubble economy. At the same time, these characteristics and consequent
propensity for over-issuance and asset Bubbles have for some time been at the
heart of dollar vulnerability.

Central banks have played a critical role in sustaining U.S. Bubble excess,
as well as supporting the dollar. The Fed collapsed interest-rates and guaranteed
marketplace liquidity. Last year in particular, Asian central banks ballooned
dollar holdings. Not surprisingly, the now evident end result is only more
acute Monetary Disorder - unwieldy Credit and speculative excess fostering
only greater financial and economic imbalances - at home and abroad.

Watching, over the past few weeks, bond prices move higher along with surging
crude has been something to behold. And then today, to again witness bond prices
surge as the dollar gets hammered, provides further evidence that something
is amiss in the financial markets. Dollar strains and heightened systemic stress
are a boon to the Treasury market. Declining Treasury yields then provides
a powerful anchor for other market interest-rates, especially mortgage borrowing
costs. And mortgage lending - with the seemingly limitless capacity for the
financial sector to transform increasingly risky loans into perceived safe
and liquid instruments - lies at the very epicenter of unending liquidity excess.
And the Bubble blows larger and tighter. I see little evidence that unfolding
systemic stress is yet impinging Credit excess in the U.S. or globally.

Ironically, contemporary finance (along with New Age central banking) has
created a strange Stability of Monetary Disorder. But it is this peculiarity
that, at least at this point, dictates the continued inflation of non-productive
Credit, dangerous financial sector leveraging, economic distortions, and excess
dollar liquidity. I see no reason to back away from the view that we are on
course for a dollar problem. And perhaps cataclysm in the currency markets
will test the mettle of contemporary "money," the "moneyness" of Credit, and
the viability of prodigious derivative markets. Could such a scenario and associated
acute financial fragility explain today's 4.2% 10-year Treasury yield in the
face of surging energy costs, a faltering dollar, and heightened inflationary
pressures?